Making Your Investments Work For You
To build and then preserve wealth you have to be an investor not merely a saver. And no matter what you invest in, your investments will have an element of risk associated with them. But there are ways you can turn these risks to your advantage. Here are a few strategies for dealing with some of the most common risks you could face.
Just one basket? How you can diversify.
It's classic advice, but definitely true: Don't keep all your eggs in one basket. Most of us get the diversification we need in our investment portfolios through
mutual funds. Each mutual fund holds many investments, so you can immediately acquire a good degree of diversification by investing in any one fund. If you hold several mutual funds, your diversification increases dramatically.
Variety means holding funds in various market sectors and in different areas of the world. Cycles in various world markets do not move in tandem with each other, so there are usually investment opportunities somewhere. It is important to choose the right mix.
Rocky road? How you can cope with a volatile market.
No one promised you that the trip is always smooth. Some investments are volatile. But if you stay the course when your investments hit a pothole, you'll do well over the longer term. The fact is, most of us don't need to know how our investments fare over the short term. If you are in the market for the long term, say 10 years or more, investment volatility really isn't a risk factor at all. History tells us that equity-oriented investments like stock mutual funds tend to rise in value over the years, regardless of the short-term ups and downs in the market.
Just around the block
Remember that volatility tends to be a short-term problem. If you're going to need your money in the near future within a few weeks or months or even several years you probably shouldn't be buying stocks or equity mutual funds. These more volatile investments could drop in value in the short term, right when you have to sell. A better strategy? Consider investing in less volatile, fixed-income investments for your short-term needs. A good choice would be a high-quality money market mutual fund.
When buying investments, you can manage the day-to-day market price swings by making your purchases on a regular basis. We call this strategy dollar-cost averaging. Suppose you invest in a mutual fund from every paycheque or once a month. Your regular purchases will buy more fund units when the unit price is lower and fewer units when the price goes up. Overall, your average purchase price will tend to be lower than the highest price you paid.
Rising costs? How you can beat inflation.
If something costs you a dollar today, it could cost you two or three times as much 20 or 30 years from now. That's inflation. And that is why you need more than a savings account or just fixed-income investments in your portfolio. These days, to counter inflation you need to have at least some growth-oriented investments, such as equities or equity mutual funds, that tend to rise in value over the years. And don't stop holding these funds once you retire, because inflation doesn't stop. With potentially 20 or more retirement years ahead of you, you need to keep your money growing at a good rate.